On The Ease of Doing Business

The ease of doing business with someone is directly proportional to how easily he or she can be duped.

It’s easy for me to do business with a child who can’t tell how many rupees I’m giving him/her as change. It’s easy for me to do business with a person who can’t tell if the vegetables I sell him are rotten.

So go ahead, people, celebrate the ease of doing business. Make it the No. 1. factor to measure the worth of nations, states, cities, whatever. The ease of doing business. Yay!

(Psst: Does someone have the numbers for British India? I have a feeling it must have been easy to do business with it. If piece-of-cake were a level of ease, British India was probably right there. Just kick the dogs; they’ll whine but in their heart of hearts, they’re willing to pay a fortune for your stuff – as the numbers show.)

Spending Power Is Not Political Power, Earning Power Is.

The States may be spending more on paper, but how much freedom do adolescents have to spend their pocket money? Spending power is not really political power. Earning power is political power. If the States were to themselves collect the money they spend, I’d call that real political power.

In a recent article, Swaminathan Aiyar argues that “The most excessive concentration of power relates to state capitals, from which power must be devolved to cities and districts.” His point is that the States account for 62% of government spending, which means we must shift the focus of the decentralization debate to within the States.

I beg to differ. The States may be spending more on paper, but like adolescents, they have not much freedom in how they spend it. Spending power is not really political power. Earning power is political power. If the States were to themselves collect the money they spend, I’d call that real political power. Let’s look at the data.

I’m not sure how Swaminathan Aiyar gets his numbers, but using 14th FC recommendations over FY 2015-16 to 2019-20, this is what I get (excluding aid, loans, etc):

Central revenue expenditure: 60,99,448 cr (32%)
State revenue expenditure: 1,29,80,292 cr (68%)

This means the Centre spends only 32% of the total public money in India. 68% of the money is spent by States. Swami’s numbers are 38% and 62%. Maybe he includes foreign aid to the Centre. Anyway, our numbers are quite close, so let me proceed to make my point.

My point is, while the Centre is spending only 32%, how much revenue is it pocketing in the first place? It’s a whopping 63%. Again, here are the numbers based on 14th FC recommendations for FY 2015-16 to 2019-20

Total revenue receipts: 1,91,04,281 cr
Central revenue receipts: 1,20,62,932 cr (63%)
State revenue receipts: 70,41,349 cr (37%)

What does this mean? The States have to spend 1,29,80,292 cr but they’re allowed to get revenue only of 70,41,349 cr. That is, the Centre is unnecessarily accumulating 59,38,943 cr. What does it do with this unnecessarily accumulated cash? It gives it away as tax devolution (roughly 66%) and grants (34%).

Although Swami makes the simple assumption that the spender wields power, the facts are more complicated. It’s actually the revenue collector who wields power. Since the Centre collects 63% of all revenue, it is possible to conclude that it wields its influence over all 63% of government spending in India.

In short, Swami’s conclusion, that the real decentralization that needs to take place is within the States, is not exactly supported by the facts presented above.

An Alternate Way To Run India’s Finances

Neither the own money nor the aid money of the States needs to be collected by the Centre. It can simply get out of this whole business of collecting and distributing money. Each State can collect all the money it needs from its own people, and we can call this as state money. In case there are States that send in any aid, it can simply be added to this and utilized with thanks.

The Government of India is under the impression that the States are fundamentally incapable of dealing with money. The idea has stuck that they can neither make money nor spend it in the right way. One can see this in the sermons the Centre gives the States on how to spend the money it gives them, both tied and untied. While it is true that the Centre collects the money in question, we must not forget that it actually comes from the people of the States. The Centre doesn’t have people of its own.

The funds that a State gets from the Centre is of two types. The first is money that originally went from the State to the Centre and returned, which we can call as the State’s own money. The second is money coming in from the wealthy states via the Centre, which we can call as aid money. Every State gets its own money back, although the wealthy States get only a fraction thereof. And then, of course, it’s only the poorer States which get any aid money.

As far as own money is concerned, it takes simple commonsense to conclude that the States can collect the necessary tax from the people directly instead of looping the Centre into the affair. This requires a reduction in the Centre’s powers, not any sort of ‘growing up’ or ‘evolution’ on the part of the States.

As far as aid money is concerned, the whole concept is based on the theory that it is good for everyone concerned. But it is important to note that this theory, right or wrong, assumes one society which the rich and the poor are part of. But this is not the case here. It is nonsensical to talk of, say, the Kannadigas and the Biharis being part of one society. They are part of one political unit, yes, but that doesn’t make them one society however much one might pretend they do.

In fact, Indian states can be called nations going by the universal understanding of the term. When a rich nation supports a poor one, it is not out of any compulsion by some sort of Central Government of the world, but out of its own self-interest. Even in the case of one State supporting another in India, there is no fundamental reason why the Centre should collect aid money and decide how to distribute it.

There are some who are concerned that if the Centre gets out of the loop, the wealthy states will no longer support the poorer ones. Opinion is divided on whether aid money to entire States is useful at all, but the worst way to address the concern is to use Central coercion. Although coercion can appear to be the ideal solution till the last moment, it can ultimately lead to the secession of the wealthy States, as has happened elsewhere in the world.

Nor is it true that if States stop giving or receiving aid money the idea of India simply dies. What dies is the thinking that aid money is central to the idea of India. It helps to note that this aid money didn’t feature in Mahatma Gandhi’s idea of India. He wanted Gram Swaraj or the independence or self-sufficiency of the village, which ruled it out.

Thus, neither the own money nor the aid money of the States needs to be collected by the Centre. It can simply get out of this whole business of collecting and distributing money. Each State can collect all the money it needs from its own people, and we can call this as state money. In case there are States that send in any aid, it can simply be added to this and utilized with thanks.

The Centre needs funds to do things the States don’t need to. As I see it, the Centre should hold only defence and external affairs portfolios and leave everything else to the States. The funds to run these portfolios, too, need not be collected by the Centre directly from the people. Over and above state money, the States can collect federal money  (money to run the Federation of India) and pass it on to the Centre.

[Photo credit: livemint.com]

No Mr. Modi, Tax Devolution To States Won’t Make Centre Much Poorer

While it is true that the Finance Commission has recommended a 10% increase in the share of the states in the divisible pool, it is not true that the award leaves ‘far less money with the Central Government’ if the Centre’s finances are considered as a whole, i.e., including money not in the divisible pool.

In his letter to Chief Ministers announcing his government’s decision to accept the recommendations of the 14th Finance Commission, Prime Minister Narendra Modi writes:

The 14th FC has recommended a record increase of 10% in the devolution of the divisible pool of resources to states. This compares with the marginal increases made by previous Finance Commissions. The total devolution to states in 2015-16 will be significantly higher than in 2014-15. This naturally leaves far less money with the Central Government. However, we have taken the recommendations of the 14th FC in a positive spirit as they strengthen your hand in designing and implementing schemes as per your priorities and needs. (italics added)

While it is true that the Finance Commission has recommended a 10% increase in the share of the states in the divisible pool, it is not true that the award leaves ‘far less money with the Central Government’ if the Centre’s finances are considered as a whole, i.e., including money not in the divisible pool. I’ve summarised the recommendations of the Finance Commission in the table below (all numbers in rupees crore).

moditable

While Mr. Modi and his government have highlighted the fact that tax devolution to states has increased as a percentage of the divisible pool (purposely omitted from the above table) from 32% to 42% in the award, one cannot conclude from it that the Centre is left with ‘far less money’. One needs to look at aggregate transfers to states as a percentage of the gross revenue receipts for it. That is what I plot in the following chart, together with the percent-wise break-up of the transfers in terms of tax devolution and grants (from the data in the above table).

2015-02-27-transferstostates.bmp

Clearly, the aggregate transfers to states (middle curve) indicated by the FC-XIV remain relatively flat before and after the 14th Finance Commission (i.e., going from 2014-15 to 2015-16 and later). In fact, the report clearly states in Section 2.28 that:

We have noted that aggregate transfers accounted for around 50 per cent of the gross revenue receipts of the Union. Keeping in view the Union Government’s expenditure responsibilities, and the need for fiscal adjustment at the Union level, we do not see the scope for increasing the transfers beyond the current level.

Historically, the actual aggregate transfers have tended to lie between 44.7% and 53.7% as a percentage of the gross revenue receipts (as explained in Section 12.6), and that is not changing. The 10% jump from 32% to 42% happening at one go in the first year of implementation, which everyone including Mr. Modi is talking about, appears when one takes only the tax devolution portion of the aggregate transfers and divides it by the divisible pool. This is not to be seen in the above chart which presents the whole picture.

In fact, this 10% jump being talked about everywhere is misleading because it masks the actual expected increase in the aggregate transfers to the states as a percentage of total money with the Centre, which is far more modest (middle curve, 47.54% in 2014-15 to 48.33% in 2015-16). The major increase recommended by FC-XIV is only in the tax devolution portion of these transfers (upper curve, 50.98% to 66.93% in 2015-16), but the grants portion is recommended to be reduced almost equally (lower curve, 49.02% to 33.07% in 2015-16).

Thus, although it helps lend Mr. Modi’s political party the hue of martyrdom, it is not correct to say that the Centre is left with ‘far less money’ because of FC-XIV. The confusion here is because only the tax devolution part of the overall transfers to the states are highlighted, that too expressed as a percentage of something other than the total money in the Centre’s kitty.

Note, however, that Mr. Modi and his government are right in their communication that the states have more of a free hand when it comes to using their funds now. This is because of the recommended and welcome shift of funds to tax devolution from grants, which essentially require state governments to do what the Centre wants them to do.

[First Published: Huffington Post March 05, 2015 at 06:54PM, http://ift.tt/1EOOigJ]

India Needs a New Economics

Indian economists have always been tempted to enter the fray and come up with their own answers to these questions. But their answers lack originality because they end up taking one or the other side of the already established bipolar intellectual space consisting of two isms: capitalism and socialism. Of course, this side-taking, this lack of originality, is not a problem in itself. Every problem in the world doesn’t require original thinking. However, our economists take sides without understanding the fundamental assumption on whose basis the bipolar economic intellectual space has come to be in the first place: the assumption of a particular kind of state.

Pick up any book on economics, and you’ll find the word state mentioned in it at least once. In fact, from Adam Smith to Karl Marx, from Freidrich August von Hayek to John Maynard Keynes, the most important question economists have been trying to answer is that of the correct level of state interference in economic activities. Should markets be completely free, or should they have state control? What should be the extent of this control?

Indian economists have always been tempted to enter the fray and come up with their own answers to these questions. But their answers lack originality because they end up taking one or the other side of the already established bipolar intellectual space consisting of two isms: capitalism and socialism. Of course, this side-taking, this lack of originality, is not a problem in itself. Every problem in the world doesn’t require original thinking. However, our economists take sides without understanding the fundamental assumption on whose basis the bipolar economic intellectual space has come to be in the first place: the assumption of a particular kind of state. Thus, without caring for whether western economists like the ones mentioned above refer to the same kind of state when seeking the correct level of its interference in markets, Indian economists turn knobs in the hope that they can come up with the correct level of state intervention for India. This is a huge problem.

I have not come across a definition from any western economist of the kind of state he or she refers to. I don’t mean to include in this definition qualities they’d like to see in the state (of which they have of course written a lot), but qualities they ignored, considered inevitable, or regarded as ideologically neutral—in short, qualities they took for granted. Since one does not list down things one takes for granted, it is understandable that western economists haven’t considered it important to clarify their definition of state for people like me. Indian economists, who have failed to set up an Indian school of economics in the real sense of the term, are in a worse position. Since their western gurus didn’t tell them, they don’t even subconsciously know what kind of state is taken for granted in their economics bibles. While western economists didn’t find it worth highlighting, Indian economists don’t even know about it, and therefore, cannot highlight it.

The best way to get out of this situation is to start from a clean slate. Western economics and its bipolar world of capitalism and socialism must be consulted if and only if, and as and when, the need arises. One thing that will stand out in this approach is that it cannot take the Indian state as it exists today for granted. This is because it is a new kid on the block, and a democracy too. Kids grow and democracies change. Indian economists who want to start anew, therefore, don’t have the luxury of taking the Indian state for granted even subconsciously. It must not only be consciously understood but also reformed if need be.

At this point, it would be unjust of me if I should refrain from writing down what, in my view, was the kind of state that western economists took for granted. Western economists were dealing with European states such as England, France and Germany, all of which had a few important features which didn’t warrant mention because of their obviousness. First, they were all culturally and linguistically as homogenous as could have been imagined. Second, they were or had been monarchies with rather stable geographical boundaries for ages. Third, the people of those states had a clear sense of who constitutes ‘us’ and who constitutes ‘them’. Fourth, those states comprised of only one level of government—‘the’ government—which meant low power-distance. Fifth, the government was comprised of people who the public could call ‘us’ from a cultural or linguistic perspective; it was not—at least predominantly not—made up of ‘others’.

Let me end this article by contrasting the above with the Indian state, hoping it provides sufficient motivation for a new Indian economics. First, the Indian state is nowhere close to being culturally and linguistically homogeneous. Second, the Indian state with its current boundaries has never been the territory ruled in its entirety by any native monarch; there have always been multiple monarchies with relatively unstable geographic boundaries within India. Third, the people of the Indian state have never in history had a sense of Indianness; Indianness has never been and is not a proper identity. Therefore, despite recent assertions that it must change, ‘us’ and ‘them’ have been and continue to be words Indians use to describe themselves as much as they use it to describe non-Indians. Fourth, the Indian state has two important levels of government, central and state, with the former farther away from the people than the latter but possessing greater power. Fifth, the central government, which holds sovereign power and can define and redefine state boundaries, is predominantly made up of ‘others’ for most Indian cultural and linguistic peoples.

It is my contention that these differences are impossible to reconcile with the existing obsequious Indian economics. What we need is a completely new Indian economics—if we want to keep India one, that is. If the current economics continues, even without the knowledge of Indian economists, the entire political economy appears to be all set to move towards disintegration, simply because that is the underlying scenario in Europe. After all, nearly every feature of the state that western economists took for granted applies not to India as a whole but to the Indian ‘states’ which were carved out after the British left.

What Would Adam Smith Think of Our Budget?

“The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with most unnecessary attention but assume an authority which could safely be trusted to no council and senate whatever, and which would nowhere be so dangerous as in the hands of man who have folly and presumption enough to fancy himself fit to exercise it.”

With the Union Budget round the corner, it’s time to recollect what Adam Smith would have thought of people presenting budgets. He writes in The Wealth of Nations:

The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with most unnecessary attention but assume an authority which could safely be trusted to no council and senate whatever, and which would nowhere be so dangerous as in the hands of man who have folly and presumption enough to fancy himself fit to exercise it.”

That is, Mr. Jaitley:

  1. Is all set to get unnecessary attention,
  2. Has assumed an authority which can’t be safely trusted to any organization (council or senate), and
  3. Is doing something most dangerous since he thinks his government is fit to exercise that authority.

Smith was talking about a country like England, with only one government followed by local bodies. In a country like India, with a Central Government that has its hold over more than two dozen culturally and linguistically diverse states, Smith’s words above are all the more applicable.

(Image courtesy: volterra.co.uk)

Some Notes on the 14th Finance Commission’s Recommendation

Basically, when you spend your money, you’re very careful how much you pay; but when you spend someone else’s money, you aren’t that careful. Further, when you’re spending the money on yourself, you try to get as much value for money as possible; but when you spend it on someone else, you aren’t that careful to get as much value.

Milton Friedman, who won the 1976 Economics Nobel, has a wonderful way of explaining how one spends money. According to him, there are four ways of spending money as depicted in the table below.

Whose money you spend On whom you spend it
Yourself Someone else
Yours I.You pay less

You get more value

II.You pay less

They get less value

Someone else’s III.They pay more

You get more value

IV.They pay more

They get less value

 

Basically, when you spend your money, you’re very careful how much you pay; but when you spend someone else’s money, you aren’t that careful. Further, when you’re spending the money on yourself, you try to get as much value for money as possible; but when you spend it on someone else, you aren’t that careful to get as much value.

Friedman talks about this in his Free to Choose in the context of welfare schemes, but I think this can be used to analyze government spending in general. All governments spend someone else’s money. That is, all governments would like to claim that they operate only in Quadrant IV above. From the table, it is clear that the people ultimately pay more than what they’d pay if they were spending the money themselves (instead of the government). However, in reality, they ultimately do operate in Quadrant III also, i.e., they do end up spending someone else’s money on themselves, too (this is called operational cost).

So what happens in all government spending is that the people pay more and get less value. It’s the most inefficient way to spend money. The best option is to be in Quadrant I. Of course, governments have to exist and they have to spend some money, so ultimately the moral of the story here is that government spending must be minimal.

Let me now go to the next step and bring in two layers of government. In India, the central government sits in Quadrants III and IV. Clearly, Quadrant III spending should be minimal, which means the size of the central government and the projects it undertakes should be minimal to begin with. Coming to Quadrant IV, the central government is the ultimate spender of all the tax revenue it collects irrespective of what the finance commissions declare to be the best revenue-sharing formula between the centre and the states.

As per the recommendations of the 14th finance commission, the centre continues to get 58% of the tax revenue. This means 58% of the money paid as tax by the people of India will be spent in Quadrants III and IV by a government which is two layers above the people (the state governments being one layer above). That’s someone else’s someone else spending your money.

As far as the remaining 42% is concerned, this revenue will be spent in Quadrants III and IV by state governments, but this doesn’t automatically mean that your money will be spent by your state government, or that your state government is spending your money. This is because the basis for distribution of central tax revenue to states is not clear from the emerging news reports about the 14th finance commission. Historically, people in the more productive states have tended to pay for those in the less productive ones, and it is doubtful that that has completely changed this time around. In short, what we need is a way for central spending to further reduce.